What does the steepness of the slope of the risk-return indifference curve indicate? The investor requires an incremental return for each new level of risk. The more risk-averse the investor is, the steeper the slope.
Why are indifference curves positively sloped and convex?
Risk averse investors will not want to take fair gambles (where the expected payoff is zero). These two assumptions of nonsatiation and risk aversion cause indifference curves to be positively sloped and convex. Figure:A high, moderately and slightly risk averse indifference curves.
Are all portfolios on the same indifference curve desirable?
All portfolios that lie on the same indifference curve are equally desirable to the investor (even though they have different expected returns and variance.) An obvious implication is that indifference curves do not intersect.
What does the vertical axis of a risk curve represent?
These curves represent an investor's preferences for risk and return. It can be drawn on a two-dimensional graph, where the horizontal axis usually indicates risk as measured by variance or standard deviation and the vertical axis indicates reward as mesured by expected return.
What does a risk/return indifference curve show?
An indifference curve plots various combinations of risk-return pairs that an investor would accept to maintain a given level of utility. If the combinations of risk-return on a curve provide the same level of utility, then the investor would be indifferent to choosing one.
What is the slope of the indifference curve?
The slope of the indifference curve is known as the MRS. The MRS is the rate at which the consumer is willing to give up one good for another. If the consumer values apples, for example, the consumer will be slower to give them up for oranges, and the slope will reflect this rate of substitution.
How is an investors risk aversion indicated in an indifference curve?
An indifference curve plots the combination of risk and return that an investor would accept for a given level of utility. For risk-averse investors, indifference curves run “northeast” since an investor must be compensated with higher returns for increasing risk.
Why are indifference curves downward sloping?
Indifference curves slope downward because, if utility is to remain the same at all points along the curve, a reduction in the quantity of the good on the vertical axis must be counterbalanced by an increase in the quantity of the good on the horizontal axis (or vice versa).
What does an indifference curve represent?
(##include msid=4006719,type=11 ##) Definition: An indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction and utility. Each point on an indifference curve indicates that a consumer is indifferent between the two and all points give him the same utility.
How do you interpret an indifference curve?
Indifference curves have a roughly similar shape in two ways: 1) they are downward sloping from left to right; 2) they are convex with respect to the origin. In other words, they are steeper on the left and flatter on the right.
What do we mean by risk aversion and what evidence indicates that investors are generally risk-averse?
Financial Economics. Evidence for Risk Aversion. Risk Aversion. A risk-indifferent individual chooses the gamble with highest expected value. A risk-averse individual will surrender expected value for reduced risk.
How does the level of risk aversion affect the curvature of indifference curves in mean standard deviation space?
How does the level of risk aversion affect the curvature of indifference curves in mean- standard deviation space. If an investor is highly risk averse, more expected return would be required for each unit of additional standard deviation where utility is held constant.
Why a risk-averse investor would consider investing on the efficient frontier?
According to the MPT, rational risk-averse investors should hold portfolios that fall on the efficient frontier (since they provide the highest possible expected returns for a given level of standard deviation).
Why are indifference curves upward sloping?
When a set of indifference curves is upward sloping, it means one of the goods is a “bad” in that the consumer prefers less of the good rather than more of the good. The positive slope means that the consumer will accept more of the bad good only if she also receives more of the other good in return.
Why indifference curves are usually drawn convex to the origin are downward sloping and do not cross each other?
Indifference curves are convex to the origin because the marginal utility of each product consumed decreases with subsequent consumption.
Why indifference curve is downward sloping PDF?
Indifference curves slope downwards. The only way an individual can increase consumption in one good without gaining utility is to consume another good and generate the same amount of utility. Therefore, the slope is downwards sloping.